Finance Commission – Issues related to devolution of resources

[oped of the day] Over to the states

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Role of states in the economic development story

Context

In the World Bank’s Ease of Doing Business index released last month, India ranked 63. It is a jump from its lowly rank of 142 in 2014. 

Challenges remain – with the states:

    • 15th FC ToR – When the government amended the terms of reference asking that allocations for defence and internal security be carved out upfront, states accused Centre’s highhandedness.
    • Land acquisition – government attempted to reform the land acquisition law by tweaking the balance in favour of investors many states objected to this. This happened despite the land being on the concurrent list in the Constitution.

Importance of states in India’s economic management

    • Early federalism – In the early years of our republic, the Centre dominated across all domains — political, economic and administrative — and states acquiesced to this unequal arrangement. 
    • Reaction to dominance – The reaction to central dominance came in the early 1980s when strong regional leaders started agitating against “the hegemony of the Centre”. Leaders like N T Rama Rao built their political careers on an “anti-Centre” platform.
    • Centre yielded – subsequently, the Centre yielded to the states largely in the political space. 
    • Economic policy spaceMuch of the economic policy control stayed with the Centre. It decided public investment and private investment through its industrial and import licensing policies. It left the states on the margins of economic management.

Economic reforms – change in relation: Three trends

    • The arrangement started to change with the onset of reforms from 1991.
    • Three trends have shifted the economic centre of gravity from the Centre to the states.

Trend # 1: Change in the content of the reform agenda

    • 1991 reforms – Centre could push through the reforms of the 1990s without even informing the states because they all pertained to subjects such as industrial licencing, import permits, exchange rate and the financial sector, which were entirely within its domain. 
    • Second-generation reforms – shift the emphasis from product to factor markets like land, labour and taxation, which often need the consent of states.
    • GST – it illustrates the increased clout of the states in driving reforms more than the GST negotiations. There was a clash of interests between the Centre and states, producer and consumer states, large and small states and coastal and inland states. The deal could not be finalised until the Centre guaranteed to fill the revenue gap of states according to an agreed formula.

Trend # 2: Fiscal federalism

    • Revenue – expenditure gap – estimates suggest that the Centre collects about 60% of the combined revenue, but gets to spend only about 40% of the combined expenditure. 
    • States collect 40% of the combined revenue but spend as much as 60% of the combined expenditure.
    • States autonomy – states now enjoy greater autonomy in determining their expenditure. Planning Commission is no more. The states get a larger quantum of central transfers and decide on how to spend that larger quantum.
    • Management of state financesThe RBI in its latest annual report on state finances raised several red flags
      • states’ increasing weakness in raising revenue
      • their unsustainable debt burden
      • the tendency to retrench capital expenditures in order to accommodate fiscal shocks such as farm loan waivers, power sector loans under UDAY and a host of income transfer schemes
    • Impact of state finances – As the RBI pointed out, the quality of expenditure at the state level has a multiplier effect on overall development outcomes.
    • Market response – The market will penalise the mismanagement of public finances. Even if it is the Centre or the states, for an unsustainable debt burden, market penalises.

Trend # 3: Economic federalism

    • Investments – There is states’ growing importance in economic federalism. They play a critical role in creating a conducive investment climate in the country. 
    • Ease of Doing Business – Much of the responsibility for improving the ease of doing business rests not with Delhi but with the states.

Conclusion

    • India’s prospects and aspiration for a $5 trillion economy depend on the Centre and the states working together.
    • If ever there was an opportune moment for a big push on cooperative federalism, it is now.
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